Economists Use The Elasticity Of Demand In Two Ways Sometime

Economists Use The Elasticity Of Demand In Two Ways Sometimes We Are

Economists use the elasticity of demand in two primary ways: analyzing the market demand curve for an industry and examining the demand curve for an individual firm within that industry. The elasticity measurement helps determine how sensitive the quantity demanded is to changes in price, influencing pricing strategies and market behavior. In this essay, I will select the airline industry as my focus, applying Sal’s scheme for identifying the type of market and evaluating the elasticity of demand at both the market and firm levels.

According to Sal’s framework, the airline industry is best characterized as an oligopoly. This classification arises because a few large firms dominate the industry, such as American Airlines, Delta Air Lines, and United Airlines, which hold substantial market shares and influence prices. There are high barriers to entry, including significant capital costs, regulatory requirements, and control of essential infrastructure like airports. While competing on price, these firms also differentiate their services through customer loyalty programs and flight routes, making the market imperfect but highly competitive at the same time (Choi & Miller, 2018).

The demand curve for the airline industry as a whole tends to be relatively elastic. This is due to the availability of substitutes such as trains, buses, or virtual meetings, especially on short-haul routes. When prices increase, consumers can switch to alternative transportation methods, showing that demand responds significantly to price changes, which is characteristic of elastic demand. Additionally, during economic downturns or fuel price fluctuations, demand elasticity can increase further as consumers cut back on discretionary travel (Gillen & Lall, 2019).

At the firm level—in this case, for a particular airline like Delta Air Lines—the demand curve is generally less elastic but still sensitive to price changes, making it relatively inelastic. This inelasticity arises because, for many travelers, especially those who frequently fly for business or have limited alternatives, the airline’s services are essential or convenient. However, the firm still faces some elasticity because customers may opt for other carriers or alternative modes if prices rise significantly (Button & Stough, 2017). Therefore, while the firm has some control over pricing, it cannot arbitrarily raise prices without risking a substantial decline in demand.

Elasticity profoundly impacts a firm’s pricing power. When demand is elastic, a small increase in price leads to a relatively large decrease in quantity demanded, constraining the firm’s ability to raise prices without losing revenue. Conversely, when demand is inelastic, the firm has greater price control, as customers are less responsive to price changes, allowing for higher prices and potentially increased revenues. For example, during periods of economic recession or fuel shocks, inelastic demand in the airline industry enables firms to maintain or even increase prices without a proportional drop in sales (Liu & Lu, 2020). Maintaining a balance is crucial for firms to optimize revenue and market share.

In conclusion, understanding the elasticity of demand at both the industry and firm levels provides critical insights into pricing strategies and market behavior. In the airline industry, classified as an oligopoly, the market demand is relatively elastic due to substitutes and consumer sensitivity. The firm-specific demand tends to be less elastic but still sensitive, influencing how airlines set prices to maximize revenue while maintaining competitiveness. Firms must carefully assess demand elasticity to navigate price-setting decisions effectively and sustain profitability in a dynamic market environment (Varian, 2014).

References

• Button, K., & Stough, R. (2017). The Economics of Transportation. Journal of Transport Economics and Policy, 51(2), 147-165.
• Choi, T., & Miller, J. (2018). Market Structure and Pricing in the Airline Industry. Transportation Research Record, 2672(8), 124-132.
• Gillen, D., & Lall, A. (2019). Strategic Airline Pricing and Competition. Journal of Air Transport Management, 76, 133-142.
• Liu, Y., & Lu, Y. (2020). Fuel Prices and Demand Elasticity in the Airline Sector. Energy Economics, 86, 104635.
• Varian, H. R. (2014). Intermediate Microeconomics: A Modern Approach. W.W. Norton & Company.